Opportunities in WA-Exposed REITs

This story features STOCKLAND. For more info SHARE ANALYSIS: SGP

-WA softer but still growing
-NSW, Qld recovery offset
-FDC growth double peers
-SGP upside to Qld demand
 

By Eva Brocklehurst

The Western Australian property market is well past its peak. Brokers attending tours of key commercial and residential assets in Perth have come to this conclusion as the resources boom starts to wane. Still, the state's economy is outperforming on some metrics. The population is growing and unemployment is below the national average. Residential property is expected to show further volume decline in 2015, while the CBD office vacancy rate, currently at 14.7%, is expected to peak in 2015. Land price growth has been a little stronger but should also start to slow. Retail turnover growth in the state was materially below the national rate in the year to September but, as JP Morgan observes, unlike the volatility in the office market, retail cap rates (income as a proportion of book value) and rents have been relatively stable.

JP Morgan expects residential volumes will remain at reasonable levels because WA has the strongest population growth and employment. House prices are up 2% in the past 12 months and while underperforming the Australian average, are still likely to stall. Citi was keen to witness first hand what effect the slowdown in mining was having on WA property. While there is evidence the residential market has slowed, demand appears to be stabilising. Land lot sales picked up in the September quarter and house price growth, while moderate, remains positive. It appears the years of above-trend population growth have not been met with a commensurate response in dwelling commencements. The risk may lie to the downside but Citi finds there is evidence of equilibrium emerging in WA. 

Key stocks in this regard are developer Stockland ((SGP)) and Australian real estate investment trust (A-REIT) Federation Centres ((FDC)). The two companies have hosted tours of WA assets and the state is a key part of their portfolios. WA consisted of 34% of Stockland's settled lots in FY14, while it represents 50% of Federation Centres' development pipeline.

Citi is forecasting a 6.3% earnings growth rate to FY16 for Federation Centres, which is more than double that expected for peers. The company has more WA exposure than any other retail landlord but Citi is increasingly comfortable about the opportunities that present. The company boasts ample balance sheet capacity for investment and new low cost debt to help fund this. The company's portfolio has suffered in the past from a lack of investment, which Citi observes was because most of the centres were held by financially distressed vehicles. Arguably this is why Federation Centres enjoys a wider array of value-adding developments. As Citi expects retail rent growth could be lower for longer, the numerous growth levers at Federation Centres' disposal stand the company in good stead.

JP Morgan likes Federation Centres as it has some strong development opportunities in WA. The company plans to spend $750m across two large projects, Mandurah and Galleria, amid the stated intention of recycling out of weak centres and enhancing others to increase the quality of the portfolio. There are three Buy ratings, one Hold and three Sell for Federation Centres on FNArena's database. The consensus target is $2.70, which signals 1.5% downside to the last share price. The dividend yield on FY15 and FY16 forecasts is 6.1% and 6.4% respectively.

Both brokers believe Stockland is similarly well placed, insulated from the mining-related slowdown by the upside to demand that is emerging in Queensland. Citi likes the potential for recovery in in operating profit margins from residential development and considers margin recovery is a more powerful earnings driver than either price or volume gains. A run-off in impaired inventory is also considered a most important driver, a multi-year event that is somewhat independent of current strength in residential markets.

WA will continue to be a moderating, albeit sizable, portion of settlements in the next few years and the brokers expects a slowing of volumes in Perth will coincide with a recovery in NSW and Queensland. Stockland has ten WA projects with around 17,000 lots for an expected end value of $4bn. JP Morgan notes Stockland's lot sales volumes provide a good indication of the Perth land market. Net deposits in Perth in the September quarter were 34% below the cyclical peak set in the March quarter of 2013 and WA's contribution to national sales reduced to 26% from 47% over the same period. The broker expects this reduction in the national contribution will continue in 2015.

Margin recovery should be the story for Stockland for the next 2-3 years, in JP Morgan's opinion. Earnings are on track for the company's 11-13% operating profit margin target by FY16. Stockland has four Buy ratings, two Hold and one Sell (Macquarie) on FNArena's database. Target prices range from $3.76 to $4.57. The consensus target is $4.31, suggesting 3.6% upside to the last share price. Stockland has a forecast dividend yield of 5.8% for both FY15 and FY16.
 

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